Who Manufactured Pinduoduo’s Counterfeit Rally?

On a day in mid-July, investment bankers from Goldman Sachs and Credit Suisse hosted a meeting with investors in New York to sell the IPO of Pinduoduo, a fast-growing and very young Chinese e-commerce company that some envisage as the next JD.com or even Alibaba. Shortly afterwards, the stock priced at the top of its IPO range and leapt 45% within a few days.

But it wasn’t long before the magic began to wear off. After peaking at a staggering valuation of $35 billion, or 125 times 2017 sales, shares of the loss-making company began a steady decline towards the IPO price of $19. In recent sessions, it has at times dipped below that level, making it a “broken IPO” in Wall Street jargon.

The nail in the coffin was news that Chinese regulators announced an investigation into the sale of counterfeit goods and items infringing on copyrights that have been sold on Pinduoduo’s platform. Pinduoduo deals mainly in very cheap items sold between third parties, fertile ground for fake goods to be exchanged. The company and Goldman Sachs didn’t respond to requests for comment and Credit Suisse declined to comment to IPO Edge.

What’s concerning is that investors probably should have been more aware of the risk. Indeed, Pinduoduo’s prospectus has many mentions of dangers surrounding counterfeit items. Deep in the 671 page document, which retail investors in particular rarely read, the company makes some serious warnings. Among them, Pinduouduo says it has been subject to allegations surrounding counterfeit items and that “potential liabilities under PRC law for negligence in participating or assisting in infringement activities associated with counterfeit goods include injunctions to cease infringing activities, rectification, compensation, administrative penalties and even criminal liability.”

Unfortunately, it’s difficult for investors – particularly individuals without extensive investing experience – to weigh the risks faced by Pinduoduo properly. There is usually scant media coverage of such companies before they go public and they aren’t allowed to communicate much under SEC regulations.

What investors do tend to notice is a hot stock that soars in its first few days of trading. And is the job of underwriting investment banks to stir up demand so that IPO shares trade well. It was no secret that “bulge bracket” banks – Credit Suisse and Goldman Sachs – were among the underwriters.

But for every strong performer, such as iQIYI Inc. – known as the Netflix of China and underwritten by Goldman Sachs – there are plenty of dogs. And many of them have had major investment banks as lead underwriters.

Take Chinese search engine Sogou Inc., which, like Pinduoduo, was backed by Tencent going into its IPO. The company was touted as a potential competitor to Baidu, the Google of China, when it sold $585 million worth of shares in late 2017. The deal, whose underwriters included J.P. Morgan, Credit Suisse and Goldman Sachs, performed well out of the gates but the stock has since fallen about 30% from its IPO price.

Similarly, Qudian, a Chinese consumer credit company, went public to great fanfare a couple of years ago, underwritten by a throng of major investment banks. Its shares priced above the indicative range but have since declined 70%.

Chinese IPOs in the U.S. Since 2017 Raising Over $50 Million – Dealogic

The real question is whether the company can move into higher-priced product categories selling legitimate merchandise or be forever relegated to a bargain basement.

“Pinduoduo has grown so fast and out of nowhere and they have a niche,” Franklin Yao, Founding Partner at strategy consulting firm SmithStreetSolutions told IPO Edge in an interview. “Some people are ok with the quality of the goods they buy being poor, but they aren’t young or wealthy people.”

Mr. Yao added that the focus on small cities will limit Pinduoduo. “In Beijing, people are rich. It’s like a first world country,” he said. “But there are already lots of e-commerce players in the upper spaces, so the question for Pinduoduo is ‘where do we go?’”

Of course, Pinduoduo may well have discovered a smart role as the host of a virtual flea market. And the issue of counterfeiting won’t necessarily fell the company altogether. But for investors looking at Pinduoduo and other hot Chinese IPOs, the lesson is that rather than rely on Wall Street’s most famous banks to find the best companies, they need to do some serious homework on their own.